Business structures

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02 Jun 2014

Dumb things we have seen – Not taking security or adequate security

READ TIME

3 min

Stupid, idiotic or incompetent? We can’t decide.

As insolvency practitioners we get to see some really dumb things. Dumb is not a word that we like to use often but it is sometimes the best word to use to describe some of the stupid, idiotic or incompetent things we see in business from time to time. Here is a recent example.

M Pty Limited operates a restaurant from premises they own. They find a buyer for the restaurant, JT. JT is a sole trader and needs some assistance with funding the purchase. He pays $190K for the restaurant (which is probably too much but that is another story) of which $130K is vendor financed by M Pty Limited. In addition to a contract for the sale of the business and a lease, a Deed is entered into between the parties in respect of the vendor finance arrangement.

The problem arises when JT gets into tax trouble and goes bankrupt. You would think that M Pty Limited, having entered into various agreements above would have adequately protected and secured their position in the event of default right? Wrong.

The terms of the Deed (which is pre-PPSA) appear fairly standard for such a vendor finance arrangement, but clearly the document has not been tailored to reflect that the Purchaser/Borrower is a sole trader.

The relevant section in the Deed in relation to the provision of security reads as follows:

If either the Borrower or Guarantor is a company, then each of them agrees if requested in writing by the Lender, within 21 days of such request and at the Borrower’s own cost and expense to give to the Lender a first fixed and floating charge over their assets referred to in the second schedule and undertaking duly signed and to cause notification of such charge to be registered in the office of the Australian Securities and Investments Commission and otherwise as may be required.

Whoops, no security. But all is not lost as there is a guarantor to the agreement right? Wrong. It seems that in using a Deed that was clearly intended for a corporation, the guarantor of the Borrower’s obligations is none other than the Borrower himself!

So by not using an adequately prepared agreement, M Pty Limited is now an unsecured creditor in a bankruptcy in which they may see a small return on their outstanding vendor finance when they could have been a secured creditor with a third party guarantee. Yes that’s right, dumb.

The lesson to be learned here is that it is always good to save a few dollars, but the smarter thing would have been to spend a few dollars and have a lawyer vet the contract.

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